How a Brazilian billionaire lost $25 billion in 18 months

Fifteen months ago, OGX Petróleo chief executive Paulo Mendonça was confident that the company he led was on track to become a major independent oil producer, an anchor for Eike Batista's vast Brazilianresource empire.

In an interview with Reuters at a Rio de Janeiro office block, Mendonça showed off bowls of pungent crude oil from OGX's first field, Tubarão Azul, or "Blue Shark," and brushed aside concerns about its operations in the waters northeast of Rio.

Sure, there had been some hiccups, but they were being fixed. Shares of OGX Petróleo e Gás Participações SA - the flagship of Batista's EBX Group - had dropped by a third from recent highs but Brazil's main stock index and other oil companies were also falling. Everything was fine, Mendonça suggested.

Then, almost in passing at the end of the one-hour interview, he dropped a bombshell: Tubarão Azul was producing only 17,000 barrels of oil and natural gas equivalent a day (boepd), and a year-end goal of 40,000 to 50,000 boepd was going to take "longer than expected."

The admission that OGX had fallen well behind its forecasts was a crucial moment in the demise of the much-hyped energy company - the first domino to fall in the rapid collapse of Batista's EBX oil, energy, shipbuilding, mining and port group.

OGX shares slumped 8.4 percent the following day as investor confidence evaporated. They had dropped another 50 percent - erasing $10.4 billion of shareholder value - by the time Mendonça resigned a month later.

Since then, things have gotten worse for Batista. Hit by mounting debt, a series of project delays and a crisis of confidence, his six publicly listed companies have suffered one of the most spectacular corporate meltdowns in recent history.

The Brazilian billionaire, who dismissed his critics as he sold investors on the promise of OGX's oil discoveries, was also EBX's biggest investor. He pumped billions into the group's companies even as share prices plunged by as much as 90 percent.

His own fortune - the world's seventh-biggest last year, according to Forbes - has declined by more than $25 billion over the past 18 months.

OGX's failure - and the subsequent unraveling of EBX - reflects Batista's initial success in overselling investors on oil discoveries that proved to be more difficult to recover than they expected.

But the story is not so simple. His empire also fell victim to the sudden end of both the global commodities boom and a wild exuberance for emerging markets - two forces that attracted investors to Batista's vision.

"Was there hubris? Was there selling a dream with little regard for the real risks? Sure," said Aldo Musacchio, associate professor at Harvard Business School in Boston. "But at the same time it was more than that. A lot of the people who invested with Batista were not fools, and his rise and fall has followed that of Brazil."

Batista agrees, to a point. In a July 19 letter published in two Brazilian newspapers, he said his empire's implosion all began with OGX. The company, he wrote, "is the origin of the crisis of credibility that has hurt my name and resulted in the clouding of the accomplishments and conquests" of EBX.

Batista stressed he was not alone in believing that OGX would succeed: "I had offers to sell a large or even controlling stake in OGX based on a $30 billion valuation." When he wrote the letter, OGX was worth $723 million.

Delcídio Amaral, a former gas and energy chief at Petroleo Brasileiro SA, the Brazilian state-led oil producer known as Petrobras, said there was no doubt Batista believed the oil was in the ground.

"He was well intentioned but wrong," said Amaral, who is now a Brazilian senator. "Nobody spends billions of dollars to build offshore oil-production ships if you're trying to pull the wool over people's eyes. It would be insane."

Batista, OGX and other companies of EBX Group have denied repeated requests to make executives available to discuss the reasons for group's decline and its efforts to reorganize.

When Batista raised $4.11 billion in OGX's initial public offering in June 2008, interest in Brazil was feverish.

Petrobras had just made giant offshore oil discoveries and Brazil was expected to become one of the world's top five oil producers by 2020.

Record demand from China drove up the price of Brazilian soybeans, iron ore, coffee, sugar and other commodities. Oil rose to an all-time high. EBX had also just sold most of its first listed company, iron ore producer MMX Mineração e Metálicos SA, to Anglo American Plc for $6.65 billion, enriching Batista and his investors.

That sale, said Elpidio Reis, a former executive with global miner Rio Tinto Plc, blinded many to the real risks of investing in Brazil generally and with Batista particularly.

Shadows of OGX's troubles were lurking in that deal. In January, Anglo American took a $4 billion writedown on the Minas-Rio iron ore project it had bought from Batista. After years of delays and costs that ballooned to $13 billion, Anglo American said it expects to start output in late 2014 at less than a third of its original target.

"Minas-Rio wasn't a dream. It was a risky project that Anglo American paid too much for," Reis said. "When Batista sold it for billions, people thought he could do the same with oil."

Like that project, OGX looked like a winner at first. Its IPO in June 2008 was Brazil's biggest ever at the time. A year later, it drilled its first well and a month after that it struck its first oil.

A former Brazilian finance minister, a former energy minister and a former chief justice of Brazil's supreme court joined the OGX board, bolstering the credibility of the polyglot, European-educated "Brazilianaire".

Major support came from the conservative, $124-billion Ontario Teachers' Pension Plan. Pacific Investment Management Co, the world's largest bond fund, bought $500 million of OGX debt.

In early 2010, OGX's fleet of drill ships was making more successful offshore oil strikes than Petrobras. In 15 months, IPO investors had nearly doubled their money.

'Fantastical' Projections

DeGolyer & MacNaughton (D&G), a Dallas-based certification company, estimated OGX's potential resources at 10.8 billion barrels of oil and natural gas equivalent. That would have been enough - if OGX could figure out how to get it out of the ground - to supply all U.S. oil needs for more than a year and a half.

OGX estimated it would produce 1.4 million barrels a day by 2019, equivalent to 70 percent of Brazil's output, or about half of the output of Venezuela, a founding member of OPEC.

Already Brazil's richest man, Batista bragged he would surpass Bill Gates, Warren Buffett and Mexico's Carlos Slim to become the world's wealthiest person. Today he does not even make Forbes' top 100 list.

"It all seems fantastical now, but you have to understand that back then, everybody wanted to invest in Brazilian oil. Petrobras had made huge discoveries and unless you wanted to invest in a complicated state-run company, the only way to get a piece was to buy OGX," Musacchio said.

The D&G estimate, seen by some as a sign that OGX was a low-risk investment, implied nothing of the sort. OGX filings and reports were clear: the D&G estimate defined the resource potential only, not recoverable oil reserves.

Critics say Batista misled investors by implying the D&G estimate was low, playing up any good news and portraying OGX in patriotic terms.

"We all know the stock market is a bit of a casino, but you want the odds to be clear," said João Fontoura, a Joinville, Brazil, lawyer organizing OGX investors for a class-action civil lawsuit. "OGX's language was strange, full of complex geological ideas mixed with the idea investing helped Brazil. We think OGX provided an overly optimistic outlook."

Hopes were certainly high: Batista expected initial production at Tubarão Azul would reach 20,000 boepd, output worth about $2 million a day at current prices. Mendonça had expected output to peak at 80,000 boepd.

In its first 16 months, though, Tubarão Azul averaged just 9,389 boepd and OGX plans to shut the field next year because output cannot pay for operations. Average monthly output never surpassed 13,200 boepd, nearly a quarter below Mendonça's May 2012 flow figure. It was 6,800 boepd in May.

Oil engineers with knowledge of Batista's plans say that in the rush to reach first production, reservoir testing at Tubarão Azul was limited. That reduced the information available to plan how to extract oil from the hard, carbonate rock formations where it was trapped far below the seabed.

Brazil's oil regulator, the ANP, never even approved a final development plan for lack of complete data from OGX. The ANP said it can allow production without a final development plan, but declined to say what data OGX lacked.

Fearful Synergies

The consequences of Tubarão Azul's failure quickly spread because of the close links between EBX Group companies.

EBX shipbuilder OSX Brazil SA was formed to build and lease a fleet of offshore oil vessels for OGX. Power producer MPX Energia SA is developing gas fields with OGX in Brazil's northeast. Port operator LLX Logística SA is home to OSX's shipyard, a place to store and process OGX oil and to ship Anglo American's iron ore.

"Among the mistakes Batista and his investors made was to see links between the EBX companies as a strength rather than a risk," said Paulo Rabello de Castro, president of SR Rating, a Brazilian credit ratings agency. "When OGX's promise turned out to be an illusion, those links became a liability very fast."

With his shares increasingly worth less and most of his own wealth invested in his companies, Batista's ability to help finance his "low-or-no-revenue" start-ups vanished, forcing him to seek new investors and give up control of MPX and LLX. He now plans to sell OSX stock to raise cash. Several times, when investor confidence faltered, Batista borrowed to invest more.

Batista may also have been hurt by Brazil's efforts to help his and other companies weather the 2008 U.S. financial crisis and the world economic slowdown that followed.

As Brazilian stocks, currency and bonds plunged, EBX stocks briefly fell to levels that were only broken this year. EBX was one of the main beneficiaries of cheap capital that Brazil's government pumped into the economy to fight the downturn.

Brazil's state-led development bank BNDES eventually committed 10.4 billion reais ($4.14 billion) of loans to EBX companies at subsidized rates. Only 6 billion reais of that have been given to EBX so far, the bank said on Tuesday.

BNDES declined to say why it has disbursed less than the full approved amount, citing banking secrecy laws, but said many loans are doled out over several years.

In Batista, the government was pursuing its then-fashionable strategy of creating "national champions" while making up for delays in its own infrastructure projects. It encouraged Batista to speed up just as Brazil's boom was about to end.

Brazil's economy grew 7.5 percent in 2010, consolidating its reputation as a global success story. OGX and other EBX companies rebounded from lows to new highs that year.

Batista and Brazil, though, have struggled since. As China slows, commodity prices are falling. In the last year Brazil's Bovespa stock index was the worst performer among the world's 28 largest indexes and the only one to fall in the period.

"Nothing could have been worse for him," SR Rating's Rabello de Castro said. "Just when Batista should have been cutting back, trying to limit expansion, complete what he started, the government gave him cheap credit to expand even more."

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